Nassim Nicholas Taleb has an intriguing piece at Huffington Post, “The Regulator Franchise, or the Alan Blinder Problem,” with a juicy anecdote at its core. It highlights a critical issue: how we’ve come to accept what other eras would view as dubious conduct as business as usual. Note that Taleb does a particularly artful job of writing in this piece, so I suggest you read it in full.

Here’s the trigger: last year at Davos, Blinder interrupts Taleb’s conversation with a third party to pitch a savings product, one that allows high net worth individuals to arb FDIC insurance regs by allowing them to put funds in a single account, which would then be split up among banks so that the investor would circumvent regulations that limit FDIC insurance (Taleb recalls as $100,000 per account, actually $250,00).

Now it’s already a bit unseemly for a former Fed vice chairman to be peddling investment products personally, particularly since, per Taleb:

….it would allow the super-rich to scam taxpayers by getting free government sponsored insurance. Yes, scam taxpayers. Legally. With the help of former civil servants who have an insider edge.

I blurted out: “isn’t this unethical?” I was told in response, “We have plenty of former regulators on the staff,” implying that what was legal was ethical.

Taleb then goes on to stress why this matters:

Alan Blinder is certainly not the worst violation of my sense of ethics; he probably irritated me because of the prominence of his previous public position and due to the context of the Davos conversation, which was meant to save the world….

Tell me if you understand the problem in its full simplicity: former regulators and public officials who were employed by the citizens to represent their best interests can use the expertise and contacts acquired on the job to benefit from glitches in the system upon joining private employment — law firms, etc.

Think about it a bit further: the more complex the regulation, the more bureaucratic the network, the more a regulator who knows the loops and glitches would benefit from it later, as his regulator edge would be a convex function of his differential knowledge. This is a franchise. (Note that this franchise is not limited to finance; the car company Toyota hired former U.S. regulators and used their “expertise” to handle investigations of its car defects).

Yves again. This may all seem to be so “dog bites man” in America so as to no longer elicit any outrage. The famed regulatory revolving door, and all the benefits that former officials and their new private sector masters gain from a legally permitted but socially destructive form of trading of insider know how is now considered business as usual in the US.

It’s remarkable to see how quickly conditions have decayed in the US. One of my colleagues, Amar Bhide, wrote a Harvard Business Review story in 1994 that was completely sincere (and would have been seen as accurate then) in describing one of the critical advantages of the US capital markets was that they weren’t simply the deepest, but also the cleanest in the world, with sound regulations, best investor investor protection, the most wide ranging disclosure.

Yet it is also clear that sound regulations can confer competitive advantage. When Singapore exited the British empire, the prospects for the island nation were poor: no manufacturing base, no commodities to exploit. Yet Lee Kwan Yew developed and executed what amounted to a national strategy, with two foundations. First was making sure the public was exceptionally well educated by Asian/emerging market standards, on the assumption that all he had was human capital. Second was the recognition that corruption was endemic to developing nations, and that having clean government would confer advantage. Yew set out to create a bureaucracy that would be hard to corrupt, and that rested on creating good incentives. Top bureaucrats were and are paid at the same level as private sector professionals (think top law firm partner). There’s little incentive to trade on your office if you don’t have much to gain. Tough internal audit was another critical aspect of this program.

But legalistic regulatory evasion has also become so commonplace as to blunt most people’s sense of where to draw the lines. One of the unacknowledged problems of the crisis is that the financial system has too little equity precisely because banks and their regulator enablers pursued securitization. The effect was to de equitize huge swathes of the credit markets (the growth of the an $8 trillion, give or take a couple of trillion, shadow banking system with pretty much no equity behind it, is the end product of this development). Regulators, financiers, and academics all touted the virtues of securitization, and its cost savings. Bullshit. The process has more moving parts, more parties ripping up front fees out of the deals. So where to the vaunted cost savings come from? De equitization, from reducing risk buffers for lending that had been deemed necessary provisions against losses. The “you’ll be on this bus or under the bus” charts McKinsey would show to clients in the 1980s explaining why securitization was inherently cheaper than on balance sheet lending showed two, and only two, big sources of expense savings: the elimination of bank equity and FDIC insurance costs.

So the “innovation” that regulators, academics, consultants, and banks were all advocating more than 20 years ago was regulatory arbitrage, pure and simple. When you have regulators undermining the rules and depicting it as virtuous, behavior like Blinder’s is simply more of the same.

Taleb describes why this behavior has become hard to root out:

First, the more complicated the regulation, the more prone to arbitrages by insiders. So 2,300 pages of regulation will be a gold mine for former regulators. The incentive of a regulator is to have complex regulation.

Second, the difference between letter and spirit of regulation is harder to detect in a complex system. The point is technical, but complex environments with nonlinearities are easier to game than linear ones with a small number of variables. The same applies to the gap between legal and ethical.

Third, regulation, like drugs, has side effects, and like drugs, it can harm the patient — something in my work I call the iatrogenics (harm done by the healer). People do not mention that regulation helped promote the Value-at-Risk method of risk measurement in replacement to age-tested heuristics — these methods blew up banks.

Fourth, we need a more severe monitoring of the activities of public officials and a solution to the following conflict. In African countries, government officials get explicit bribes. In the United States they have the implicit, never mentioned, promise to go work for a bank at a later date with a sinecure offering, say $5 million a year, if they are seen favorably by the industry. And the “regulations” of such activities are easily skirted.

Fifth, and more philosophically: during the lunch with Arianna, the conversation kept sliding into the ethical basin of attraction, the compatibility of some professions and service of the public. The Greeks had respect for the banausoi, those who had to make a living in the professions, but many argued against trusting them in running the affairs of the city on grounds that “a funeral goods merchant would not be trusted to wish for the good health of his fellow citizens.” The point has been debated through the ages, from Xenophon to Seneca (who took the opposing point), but it is even starker today in the age of lobbyists and a shift in middle class values that tolerates the “everyone needs to make a living” even when the means to “make a living” are harmful to society.

These accumulated moral hazards have blown up banks and will keep blowing up the system.

Yves here. Unfortunately, the Obama administration had the opportunity execute more fundamental reform at the outset. Worse, Obama himself recognized it; he was reading biographies and speeches of FDR as president elect, yet chose to pass on an historical opportunity.

Although I have not read Depression era politics extensively, it appears two critical elements are missing now. One is that despite the chicanery of the Roaring Twenties, ideas like character and public service still meant a great deal. Those values are pretty much dead now. Second was that Roosevelt was not cowed by bankers or businessmen. For instance, when he told his economic advisers (rather out of the blue) that he was going off the gold standard (which the US had done as an expedient, but the assumption was it would go back soon) he was met with a firestorm of criticism which he airly brushed aside. I can’t imagine any senior politician now having the confidence now to defy the will of the banking industry. And it isn’t simply due to the role of corporate funding in campaigning; the roots are deeper. Being in office now is all about winning, about keeping one’s hold on power, so it isn’t surprising that everyone has a price.

Update 2:00 PM: Some readers have objected to this post, pointing out that while Taleb is correct in general, his attack on Blinder is misguided. If nothing else, this issue reveals the considerable change is what is considered to be acceptable conduct. In the 1960s, it would have been unheard of for a former senior regulator to solicit interest in a financial product, irrespective of what one thought of the fact that it exists solely to make it easier for customers to work around inconvenient regulations. And the FDIC itself sends mixed signals (this link is from a few years ago, but there is little reason to think the underlying stance has changed much):

Deposit insurance has a simple, but important purpose: to provide a safe place for depositors to keep their money, as a way to prevent bank runs and maintain the stability of the banking and financial system.

Since 1934, the basic coverage amount has increased five times, from $5,000 to $100,000. Most of the increases more or less reflected cost-of-living adjustments, but the most recent increase is an exception. The 1980 jump from $40,000 to $100,000 had more to do with attracting deposits to insured institutions in a competitive market of very high interest rates. Today, 20 years later, $100,000 of deposit insurance has lost about half its value, based on the Consumer Price Index.

The next several decades will be a time in which the population is aging, retirement costs are increasing, and the supply of federally-backed investment vehicles, such as Treasury notes and bonds, may decline. Thus, a long-term perspective may argue for allowing for the coverage limit to keep up with changes in the price level, household wealth, or other measures relevant to households.

However, there are trade-offs to consider. Higher coverage limits can increase moral hazard. The 1980 increase is widely viewed as contributing to the high cost of the savings and loan crisis. Also, the impact of higher coverage limits on insured deposit growth is difficult to predict, and the likely distribution of benefits is subject to debate.

So….FDIC insurance is to prevent bank runs. No mention of the reason for the ceiling (to reduce overall cost? Because big investors can take care of themselves and can buy risk free investments like Tbills directly?). A clear indication that deposit ceilings were increased in 1980 to allow banks to compete more effectively with money market funds, and that had adverse consequences.

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103 comments

This all makes eminent sense. We must be very skeptical of so-called reforms that make our already bewildering system of laws and regulation more complex. The complexity itself acts like a tax and is a huge source of corruption.

Ideally, the Federal government would be limited to a total body of laws and regulations no larger than a typical adult could remember.

When you say “how we’ve come to accept what other eras would view as corruption as business as usual” I think you underestimate the corruption that also pervaded other eras, even if it was a little different and applied to different circumstances. I’ll leave it at that.

As to a good solution to regulatory capture, I had e-mailed you a solution that I personally came up with though I don’t believe you gave yourself the time to read it. It’s definitely something different…you should really take a look at what I wrote.

The third critical element missing from the 30s is the existence of an alternative on the left — the trade union movement was decades old and quite active. That and the heady specter of Communism convinced the wealthy that Roosevelt wasn’t the worst opponent they faced.

With all due respect to Yves’ and Taleb’s work (I’m a big fan of both) I think there are much better examples of corruption and abuse of former regulator status than this one.

The FDIC deposit insurance program does not prohibit a single individual from having multiple accounts at different banks in amounts below the FDIC insurance threshold, and therefore protected. So describing what Blinder and his company are doing as “circumvent(ing) regulations”, as Yves does, is inaccurate.

One of the reasons the FDIC does not limit the number of accounts a single individual can have covered by FDIC insurance is that spreading that person’s accounts across different banks diversifies risk.

Instead it would appear Blinder’s firm is providing an efficient mechanism to utilize FDIC insurance within the FDIC’s parameters.

Why even have a limit if you can run around it with the help of wall st ,while they take their cut, and push all of the risk to the tax payers?

I’m sure it’s all very efficient.

In my mind the intent and letter of the law are very plain, 250 k per person per bank. Mr. Blinder, with the help of his other ex regulators, is setting up a “supra-bank” with no real efficiency beyond that of regulatory arbitrage. They also have no capital requirements, pushing all of that “real banking stuff” on to the people below them.

They are being paid to take advantage of the system. It’s that simple and unethical. You can’t legislate ethics, but you can legislate banking regulations. They did this a while ago, and the unethical Mr. Blinder ran right around the law.

The regulation in principle is intended to deal with an outsider figuring out what to do on his own. The limit, of course, is intended to provide a public backstop for the public’s savings, not for rich rent-seekers, i.e. criminals.

It’s not set up to be worked by a “public servant” who is really a traitor, selling his public service expertise to help outsiders game the system.

(Of course by now the system’s been hijacked so that e.g. the practical intent of FDIC insurance is precisely to socialize the risks and costs of criminal activity. Traitors like Blinder have dedicated their careers to making it so.

That’s precisely the state of affairs Taleb is deploring here.)

As for the “efficiency” Big Lie, we know for a fact that every action of the finance sector doesn’t create wealth but destroys it. It does nothing but add cost and complexity. No one ever games the system to render “the economy” more efficient; he does it to render the economy less efficent. He does it only to render his own crimes more efficient.

Here’s one study which finds that banksters and speculators destroy $7 of social wealth for every $1 they create.

As Taleb himself sometimes notes, the most important element missing from the 30s is that we have not yet destroyed the bad debts choking the system, a process which was largely complete before Roosevelt even took office.

These bad debts — and the banksters who hold them — need to be liquidated. The associated economic pain cannot be avoided, and the question of whether it is done through massive defaults or inflation is mostly a matter of picking the marginal winners & losers (or, more accurately, the losers-of-a-little and the losers-of-a-lot).

Andrew Bissell said: “…the most important element missing from the 30s is that we have not yet destroyed the bad debts choking the system, a process which was largely complete before Roosevelt even took office.”

That is factually incorrect.

In Since Yesterday Frederick Lewis Allen describes the economic disaster Hoover’s laissez faire ideology created which he then handed off to Roosevelt:

Hoover had tried to keep hands off the economic machinery of the country, to permit a supposedly flexible system to make its own adjustments of supply and demand. At two points he had intervened, to be sure: he had tried to hold up the prices of wheat and cotton, unsuccessfully, and he had tried to hold up wage-rates, with partial and temporary success; but otherwise he had mainly stood aside to let prices and profits and wages follow their natural course. But no natural adjustment could be reached unless the burdens of debt could also be naturally reduced through bankruptcies. And in America, as in other parts of the world, the economic system had now become so complex and interdependent that the possible consequences of widespread bankruptcy–to the banks, the insurance companies, the great holding-company systems, and the multitudes of people dependent upon them–had become too appalling to contemplate. The theoretically necessary adjustment became a practically unbearable adjustment. Therefore Hoover was driven to the point of intervening to protect the debt structure–first by easing temporarily the pressure of international debts without canceling them, and second by buttressing the banks and big corporations with Federal funds.

Thus a theoretically flexible economic structure became rigid at a vital point. The debt burden remained almost undiminished. Bowing under the weight of debt–and other rigid costs–business thereupon slowed still further. As it slowed, it discharged workers or put them on reduced hours, thereby reducing purchasing power and intensifying the crisis.

It is almost useless to ask whether Hoover was right or wrong. Probably the method he was driven by circumstances to adopt would have brought recovery very slowly, if at all, unless devaluation of the currency had given a fillip to recovery–and devaluation to Hoover was unthinkable. It is also almost useless to ask whether Hoover was acting with a tory heartlessness in permitting financial executives to come to Washington for a corporate dole when men and women on the edge of starvation were denied a personal dole. What is certain is that at a time of such widespread suffering no democratic government could SEEM to be aiding the financiers and SEEM to be simultaneously disregarding the plight of its humbler citizens without losing the confidence of the public. For the days had passed when men who lost their jobs could take their working tools elsewhere and contrive an independent living, or cultivate a garden patch and thus keep body and soul together, or go West and begin again on the frontier. When they lost their jobs they were helpless. Desperately they turned for aid to the only agency responsible to them for righting the wrongs done them by a blindly operating economic society: they turned to the government. How could they endorse a government which gave them–for all they could see–not bread, but a stone?

The capitalist system had become so altered that it could not function in its accustomed ways, and the consequences of its failure to function had become too cruel to be borne by free men. Events were marching, and Herbert Hoover was to be among their victims, along with the traditional economic theories of which he was the obstinate and tragic spokesman.

Unfortunately, over the past 30 years, there has been a revival of the ideologies that Hoover embraced so vehemently, and with equally disastrous results.

Therefore Hoover was driven to the point of intervening to protect the debt structure–first by easing temporarily the pressure of international debts without canceling them, and second by buttressing the banks and big corporations with Federal funds.

“Laissez-faire,” right. Sounds more like corporatism (and very similar to Obama’s policies) to me. Unless “brook no liquidation” is now considered some kind of hands-off approach to the economy.

As your charts show, there may have been some defaults of B-rated bonds along the way, but the debt structure for all intents and purposes was kept intact, both under Hoover and under Roosevelt. Roosevelt actually streamlined the RFC’s cumbersome bureaucracy and increased its funding, which meant not only faster but more aid for failing banks.

“But no natural adjustment could be reached unless the burdens of debt could also be naturally reduced through bankruptcies. And in America, as in other parts of the world, the economic system had now become so complex and interdependent that the possible consequences of widespread bankruptcy–to the banks, the insurance companies, the great holding-company systems, and the multitudes of people dependent upon them–had become too appalling to contemplate.”

So your source says. And you attribute this to laissez-faire policies? What precisely, can you tell me, was laissez-faire about the federal reserve act that bound all of these banks together? Or the prior long history, dating to Washington, of federal involvement in banking? Or about the gold exchange standard that had the entire world riding on two inflating currencies? Do you attribute the first world war and all of its fallout to “laissez-faire” ideology? A word is nothing without the ability to apply it, and your examples are poor fodder if they merely emulate your penchant for ignoring all context so that you might condense history into a label too small to hold it.

Meanwhile his [Coolidge’s] Secretary of Commerce, Herbert Hoover, ingeniously helped business to help itself; on the various governmental commissions, critics of contemporary commercial practices were replaced, as far as possible, by those who would look upon business with a lenient eye; and the serene flattering pronouncements upon business and assurances that prosperity was securely founded.

An uninspired and unheroic policy, you suggest? But it was sincere; Calvin Coolidge honestly believed that by asserting himself as little as possible and by lifting the tax burdens of the rich he was benefiting the whole country–as perhaps he was. And it was perfectly in keeping with the uninspired and unheroic political temper of the times. For the lusty businessmen who in these fat years had become the arbiters of national opinion did not envisage the Government as an agency for making over the country into something a little nearer to their hearts’ desire, as a champion of human rights or a redresser of wrongs. The prosperity band-wagon was bringing them rapidly toward their hearts’ desire, and politics might block the traffic. They did not want a man of action in the Presidency; they wanted as little government as possible, at as low cost as possible, and this dour New Englander who drove the prosperity band-wagon with so slack a rein embodied their idea of supreme statesmanship.

“So your source says. And you attribute this to laissez-faire policies? What precisely, can you tell me, was laissez-faire about the federal reserve act that bound all of these banks together? Or the prior long history, dating to Washington, of federal involvement in banking? Or about the gold exchange standard that had the entire world riding on two inflating currencies? ”

Oh, so the banks went under because of the fact that they were “linked together” by the federal reserve, ie they were all part of the club? My guess is you’re implying they drank the same shot of whiskey, am I right? Well? Tell me more, please….and please don’t give me the interest rate argument, that has nothing to do with the banks being “linked”.

“Do you attribute the first world war and all of its fallout to “laissez-faire” ideology? A word is nothing without the ability to apply it, and your examples are poor fodder if they merely emulate your penchant for ignoring all context so that you might condense history into a label too small to hold it.”

Ok, let’s forget about the depression for a second. Explain for all of us what happened to cause this crisis, in specific detail.

And it’s funny that you tell us not to apply “laissez-faire” unless we give context, when those that support it most never give context, except to say NO GOVT. Then when a crisis occurs, you still blame the government despite the fact that you previously recognized the economy as “laissez-faire” and thus your solution is that it wasn’t pure enough. Simple minded fool. You’re nothing more than a charlatan, fooling yourself to believe an IDEOLOGY, something you yourself never give context to and never clearly define. Indeed, when will your pure laissez faire ever occur? Let me guess…”If only…” “IF ONLY…”

I agree with Taleb’s point but I think his choice of examples is not particularly good. He’s referencing the CDARs program which allows people with more than $100K to deposit in a bank (actually I believe it’s now $250K) to essentially spread around their deposits more easily. So, if you’ve got $1 million to deposit, instead of going to four separate banks and depositing $250K in each one, you can just go to your local bank and the CDARs program will do it for you/them. So, you maintain the relationship with one bank and that bank handles the distribution of the funds to the other three banks through CDARs. In exchange for this service – and that’s what it is – the “rich” depositor receives a lower rate of interest than they would otherwise receive. So, this isn’t really a “subsidy for the rich.” The rich, after all, could do this themselves, but at a cost. The CDARs program pays them less interest in exchange for handling the diversification. I see nothing wrong in that, nor with former regulators being involved in the company that handles it. But, again, I do agree with Taleb’s larger point. I just have a quibble with the specific example used.

If the rich (or anyone else, really) want a 100% guarantee of the return of their principal, they should put their money in certificates of indebtedness with the U.S. Treasury. They don’t yield anything, but interest is something you’re supposed to be paid for taking risk, not abusing government guarantees and subsidies.

Yeah, but they’re not “abusing government guarantees and subsidies” here. They’re paying someone to help them do something they can legally do themselves. Now, if your argument is that NO ONE should be able to have a government guaranteed return via an FDIC-insured bank account, that is a debatable issue, but it’s also a completely separate argument from the one Taleb is making.

The differences from your examples are rather stark, in fact. The tickets for the “latest greatest show” are limited. There is no such limit for how much folks can deposit into the banking system as a whole (perhaps there should be – that’s a separate issue – but there isn’t). Buying a kidney – same issue, a limited supply of kidneys. The draft during wartime – same issue, a limited supply of soldiers. My point is that you’re comparing apples and oranges here.

The cost is NOT “borne by the deposit holders of other institutions under the umbrella of the FDIC” or the US taxpayer. Again, the deposits would make it into the system (via different banks) ANYWAY. They would be insured ANYWAY. The CDARs service is making a profit on providing the service to folks who would otherwise be doing the exact same things themselves.

Having said that, I agree that there are too many TBTF banks. And I also agree that the CDARs program makes it easier for the TBTF banks gather deposits. But I’d rather keep the CDARs program and either (1) break up the TBTF banks (or, actually, just require them to carry a crappile more capital) or (2) not allow the TBTF banks to participate in the CDARs program. I see no issue with the program itself, but I would agree that it opens up the possibility for abuse by the TBTF banks.

We’ve drifted a long way from the principles of General George Marshall, who refused to write and publish his memoirs because he believed it would have been unethical for him to personally profit from work that the government had already paid him. He lived out his declining years on his military pension and modest personal savings and investments.

You cannot possibly hope to prove this; every figure you could point to for improvement post-1933 is tainted by the money inflation Roosevelt brought with him. And the fact remains that the depression continued, unabated, until our factories were the only ones in the world left standing.

Suspension of specie payments was not FDR’s brainchild, either. It had been occurring routinely in this nation for nearly 150 years. He was not “brave” to repeat this form of bank bailout, which had already led, long before
he took office, to the creation of a corrupt and corpulent banking system. The schism between gold and paper was permanent this time only because the government, taking a cue from the banks, began issuing debt that it had no intention of paying back in full. You may call this bold, or you may call it unethical – this is, after all, a discussion that began on ethics – but do not be so convinced of success when not 80 years have elapsed, and the decisions of which we speak have yet to reach their final conclusions.

Costard said: “…every figure you could point to for improvement post-1933 is tainted by the money inflation Roosevelt brought with him. And the fact remains that the depression continued, unabated, until our factories were the only ones in the world left standing.”

That is factually incorrect. The “inflation” was imaginary, and the fears of inflation were unfounded and led to disastrous policy decisions.

At last business conditions in the United States were definitely improving. The Federal Reserve Board’s Adjusted Index of Industrial Production (which as you may recall had sunk as low as 58 and 59 in the crises of 1932 and early 1933, had leaped to 100 during the New Deal Honeymoon, had then slipped back to 72 by November, 1933, and had obstinately hung in the seventies and eighties throughout 1934) had now begun to show a pretty definite upward trend. By the beginning of 1935 it had risen as far as 90. By the end of 1935 it had reached 101. And after a brief relapse into the nineties, it swept on during 1936 to 104 in June, 108 in July and August, 109 in September, 110 in October, 114 in November, and 121 in December–within striking distance of the record figure of 125 which had been set in 1929.

[….]

Then see what happened to our familiar measure of the state of business in general, the Federal Reserve Board’s adjusted Index of Industrial Production. (Do you recall its previous ups and downs? Its high of 125 in 1929, its low of 58 in 1932 and of 59 in the bank-panic month of 1933, its rush up to 100 during the New Deal Honeymoon, its decline to 72 as the Honeymoon ended, and its wobbling rise thereafter?) At the end of 1936 the index had touched 121, which looked distinctly promising. As late as August, 1937, it stood at 117. Then it ran downhill, month after month, until by May, 1938, it had sunk to 76. _In nine months it had lost just about two-thirds of the ground gained during all the New Deal years of painful ascent!

What had happened? During the latter part of 1936 and the early part of 1937 there had taken place sharp increases in the prices of goods–some of them following increases in wages during the CIO’s offensive, some of them affected by armament orders from Europe, many of them accentuated by a general impression, among business men, that “inflation” might be coming and that one had better buy before it was too late. The price of copper–which you will recall especially disturbed the President–had jumped in five months from 10 cents a pound to 16. Business concerns had been accumulating big inventories. When the time came to sell these goods at retail to the public, the purchasing power to absorb them just was not there.

For new investment still lagged; and what was more, the government spending campaign, which had kept pumping new money into the economic system, had been virtually halted. During the summer of 1937, Henry Morgenthau, the Secretary of the Treasury, had persuaded the President to make a real attempt to balance the budget; and although it did not yet seem to be quite in balance, nevertheless when one took into account the Social Security taxes which were being levied (and were not counted on the credit side of the budget, being set apart in a separate account), the government was for a time actually taking in from the public more than it paid out.

Result: the goods which were piled up on the shelves moved slowly. Business men became alarmed and cut production. Two million men were thrown out of work in the space of a few months–and became all the less able to buy what was for sale. The alarm increased, for men well remembered what a depression was like and were resolved to cherish no false hopes this time. The vicious spiral of deflation moved with all the more rapidity. Thus out of that apparently clear sky–no great speculative boom in stocks or real estate, no tightness in credit, no overexpansion of capacity for making capital goods (in fact, not nearly enough expansion)–came the Recession of 1937-38.

Call it what you may, but your original assertion that the “depression continued, unabated, until our factories were the only ones in the world left standing” is patently false, as Frederick Lewis Allen amply demonstrates.

This is a little off point, but a few weeks ago I heard Nicholas Taleb speak. I then read his book and thought it was amazing. Today I was reading Yves Smith’s book, ECONNED, and there are parts of Ch. 2 that sounded like Smith and Taleb were either collaborators or of similar cloth. Now this post (which I wholly agree with).

I’ve personally witnessed this pandemic and its very sad. As an insider I know there are a lot of good people doing their work in an ethical manner. Unfortunately, like most professions, there are those who do game the system and the seduction to turn to the dark side is always implicit.

“So the “innovation” that regulators, academics, consultants, and banks were all advocating more than 20 years ago was regulatory arbitrage, pure and simple. When you have regulators undermining the rules and depicting it as virtuous, behavior like Blinder’s is simply more of the same.”

Productive economic behavior has been left for another time while gaming the system is a full time profession. America’s love affair with getting rich and richer doesn’t mean risking your money rather OPM legally acquired via the political and regulatory system is what’s left of our economic heritage.

The big difference is that there was a international Communist movement that scared the crap out of capitalists in the 1930’s and that appealed to working people. FDR’s liberal policies, like Keynes, could be sold to smarter sections of the elite as a way to ‘save the system’ because the alternative , expropriation of private capital, was so much worse.

Without any push back from working people, this will just continue onwards until the entire system blows up in an orgy of greed and militarism in a way that will make 2008 seem like a picnic. But that could be a long way away.

If the highlight of the American experience was Watergate, were without a shot being fired, the PTB were replaced in their entirety. All due to a generally educated, informed and involved populace and Congress that understood public service. Yes, our Constitutional framers would have been proud.

Now we have a specialty educated populace who is uninvolved, uninformed to the point of purely parochial, local views and completely uncaring. We let “Volunteers” do the dirty, bloody job of fighting, dying, and becoming physically and mentally scarred for life. When 66 GI’s die in Afghanistan in a month, people don’t demonstrate, not even a wince — they take the view that our soldiers knew the chances when they Volunteered and it comes with the occupation.

Balderdash.

Politicians, officials, most everyone makes deals — It’s reasoned that the End justifies the means. In fact, they reason, there is no one to notice or care.

In fact — regulators, prosecutors, those in positions of Public Trust (How Quaint) are all part of the team effort. Look the otherway, so do the majority of American citizens — unless you are out of a job, out of benefits, and perhaps have hungry kids — Then suddenly you care, but it’s too late.

Does anyone ever tell the truth ? Do people even know what truth is ?

The New Regime:

Today, we live in a complex society were labryinthe problems often require Machiavellen solutions where decisions must be only left to those who are on the inside –where the average citizen wouldn’t understand, and seemingly doesn’t care. Truth, Justice Equality, Integrity, Character, Ethics — They are all too often simple, quaint, too well defined concepts that have no place in today’s governance. After all, most people don’t question a doctor’s decisions — so why should one question your leaders decisions. If a little protest helps the medicine go down, so be it.

Power Trumps Money &, Money Trumps Individual Rights

The last vestige of a bygone America that still lives are the men and women of our uniformed services — They have no collective unions to voice grievances, no petty beefs — They do as they are told for the protection of America

— That is until they are finally disillutioned — they too have families back home that struggle like the rest —

So God Bless Hollywood — America can live for ever like a Dicksonian novel.

But when the next war comes, and along with it a Draft, for ourselves and our children, — we will be expected not to question or reason, just fight and die without ever knowing why.

still have an Integrity, character, ethics have gone the way of the slide rule.

As cynicism is truth, I think it’s safe to say that any cynicism expressed in public would never be uttered by a veteran (K street) lobbyist or from anyone in an important leadership position actually. The “troops” (whoever they happen to be at the moment) ALWAYS need the fakery of optimism to allow for the greater glory of the nobility benefitting from their glorious sacrifices.

Generally I don’t follow Taleb but I agree with him. Even the best-meant regulation creates entrenched interests and advantaged elites.

As for the ethics of the situation…. At one point, governments merely granted monopolies, and the flow of benefits was straightforward. Now, in deference to modern political theory, every decision of who shall do business and who shall not is cloaked in the mantle of the “public good”. The results are indistinguishable. However the unethical aspect of the situation is more a result of our increasingly benign view of government, and its increased scope, rather than any change in behavior on the part of rent-seekers and politicians.

Those who see a powerful state as a white knight will always be disappointed in this way by the reality of things. In their eyes the fault will always lie with black conspiracies, or with a human race too flawed to live up to the ideal; but reason says, and history shows, that every state is as corrupt as it is powerful.

Indeed sorry to hear you are out of work. Yes, it is now quixotic to be brave or principled in a true sense. Certainly compliance with the “values” and rules of the state and powerful are the only way…..Where do I fit? Old fart, used to be economist, developer and lobbyist, I was part of the problem and then checked out so to speak, sick of the people I worked with, dealt with and ashamed of my self….

It’s also overrated, which is why it’s so rare. If it was common the liars who write the history books wouldn’t need to work so hard to find examples of it.

Winning (and business and war) is about screwing somebody. The workers, management, customers, & stockholders are better off when each realizes the only motive of the others is to maximize their wealth. Life is about the smart amoral scumbags screwing the dumbasses for fun and profit. History is allot more understandable when view in this light.

Moral: Honesty is very seldom the best policy when dealing with the smarter people.

There is an irony here. Taleb, who tends to be favourably oriented towards free markets and is a big fan of Hayek has often made arguments about how regulators are necessary and has stated that the libertarian position, which would eliminate most of the government functions with the exception of protecting individuals from force or fraud, was too extreme. Blinder’s actions are an example of why the libertarians are right and why being a ‘moderate’ on the issue of economic or social liberty is a path towards serfdom.

There is nothing confused about noting that libertarians have it right when they point out to the damage caused by big government. Blinder is a hypocrite who writes commentaries against the danger of blanket deposit coverage at the same times as he creates products that provide just such coverage.

I remember in the Eighties and early Nineties when the US were accusing Japan of so many unfair and wrongful practices and one of which was the idea of senior government officials joining the private sector. It was called ‘amakudari’ meaning descending from heaven, as in these officials would use their influence and knowledge in public service to serve their own ends as well as for the companies they joined.

Surely the USA is no different now? In my 50s now I realised people should be slower to accuse each other especially Asians of wrongful practices when they too have their own backyards to watch. Yes I am an Asian working in Asia.

Thank you for your comments. Not only is the USA not only “no different”, I’m certain it is much worse, given that there are no protections here for consumers whatsoever. Falling from grace here means finding more ways to fleece the poor without the government saying a word…in fact, BECAUSE of these former government employees they(the government) actually encourage behavior that further enriches those corporations. Taleb’s encounter with Blinder is just one small case among many larger cases.

You are not excused to demur about anything of the sort. If you want to talk about exploitable gaps there is a plethora of information out there, so much that the regular news media is able to report on it daily.

Taleb’s argument is linked to regulatory capture…if you knew how much worse capture is than “exploitable gaps” then you wouldn’t be making your silly comment to begin with.

In other words, at least 1,400 ‘franchises’ built on complex information, a multitude of variables, and (as Taleb points out) many ‘nonlinear’ relationships that make the system easy to game.

If public service were more highly valued, it would be better paid and the entries would become more rigorous (in some places, they already are). It appears that Singapore took the potential of ‘human capital’ more seriously than the Obama administration has done.

After 30 years of anti-government ranting in the US, we’ve lost sight of the enormous value that a viable, non-corrupt, respected, well paid civil service can bring to an economy.

Self-interest, unenlightened, has led to the situation in which we have 1,400 ‘franchisees’ on FinReg alone.

Yves says: “The famed regulatory revolving door, and all the benefits that former officials and their new private sector masters gain from a legally permitted but socially destructive form of trading of insider know how is now considered business as usual in the US.”

Sorry, this does not hold water. There is no “insider know how” at work here. The FDIC itself makes it clear in its brochures (pick one up at your bank) that it’s perfectly OK to have multiple insured deposits at multiple banks. It even gives specific examples to make sure people understand how to do it. Nothing unethical here. The limits per depositor per bank exist to make sure the government’s insurance risk is spread around to multiple banks. That’s all there is to it. And many people have been doing this for a long time, without being insiders, and it’s both legal and ethical.

BTW — Blinder worked in the Clinton administration, and is a pro-stimulus liberal professor of economics. Taleb is anti-stimulus and, in general, on the conservative side especially with respect to deficits.

You are missing the point. The wealthy person who obtains the service does not set up multiple accounts, he has a single account. He is spared the operational hassle, which is a disincentive to having multiple accounts. The usual low risk alternative for someone who wants low hassle and no risk would be a Treasury money market fund, which involves no taxpayer support (FDIC deposit insurance is underpriced; Treasury has repeatedly had to provide support to the FDIC).

Read up on the IndyMac bankruptcy. Many of the depositors who were suffered losses by having over $100,000 at IndyMac were businesses. If you have a business with any meaningful payroll, it is pretty much impossible NOT to have an account with over $100,000 in it for more than a few days a month. Things have probably changed since then, but at that time, the software used to manage payroll processing could work only with single accounts (as in it would have been prohibitively costly to split a business account used for payroll among multiple banks).

Was the Blinder service marketed to high transaction volume customers like businesses, who really could not follow the FDIC’s suggestion? Could they even have used that service (ie, did it have monthly transaction limits that would have made it unworkable for the businesses that would really have needed it?) I don’t know the answer, but I suspect not.

I am aware of what this business (and other similar “brokered deposit” businesses) offers. And I still say that putting together a business like this requires no “insider knowhow”. Furthermore, for this to be unethical, you would have to show that the rationale for the per bank FDIC limits was to make it difficult for depositors to use multiple banks. I believe that this is a wrong assumption — rather, the government simply wanted to spread the insurance risk to multiple banks. FDIC goes out of its way, in its literature (and on its website), to make sure everyone knows about the multiple bank option. FDIC insures banks, not individuals. They just don’t want the risk to be concentrated.

And by the way, do you really believe that Mr. Taleb has all his Black Swan money in a single bank account? (I’m guessing he knows a lot better how to “insure” his own portfolio, using methods and real insider knowhow that the average Joe cannot come close to). And it’s always possible for any large investor to buy treasury bills in any amount — so what’s the big deal here?

The ‘big deal’ is the persistent upward bias of our system of legal and financial complexity.

Largely single-handedly, this bias (which extends well beyond any individual financial regulation but also into civil AND criminal law, taxation, trade, labor rights, and the legislative process itself)…

has not only destroyed the middle-class, but the sense of common purpose that holds a nation together.

A peripheral, but I believe excellent example is the minor issue regarding the registration of Senator Kerry’s yacht to avoid some local taxes…

He’s a good liberal!!! But this is a trait shared by the wealthy of BOTH DAMN PARTIES. And nothing is thought of it.

(I know this from personal experience, while I’m now quite poor, my ex-wife is a member of the House of Savoy whose father was one of the four men who created MCA…)

When the wealthy consult their coterie of advisors, they feel entirely justified following it with little thought of how they are using ‘experts’ to escape responsibility for the social consequences… especially over time.

Frankly, now as I enter the world of the poor… it becomes increasingly apparent how much bias there really is in the system AGAINST those on the low end… (It’ll make a good blog post at some point).

The ‘initiative’ that the ‘ownership’ class constantly ascribes to their skill at ‘investment’ (Adam Smith would rollover in his grave)… and the ‘value’ that they claim is owed to them because of it…

is very much displaced.

And the rest of us are catching on.

P.S. My ex-wife is a good woman… but in a way, that’s the point… I’m sure Senator Kerry means well too…

But this may be why the more “Commons-centered” politicians (supposedly the Left or Liberal side) is so half-hearted.

Rich politicians will NEVER really be able to understand… or be motivated strongly enough to really make the changes necessary.

When the wealthy consult their coterie of advisors, they feel entirely justified following it with little thought of how they are using ‘experts’ to escape responsibility for the social consequences… especially over time.

Exactly. Precisely.
Indeed, it confirms their existing biases that they are the best-smartest, etc, etc.

And your point that they can be *very* pleasant, agreeable people is also well worth noting. Gracious, agreeable, and enjoyable.
The problem is that the more convoluted the system becomes, the less they are able to distinguish between the benefits they glean from their personal skills, as opposed to the benefits that accrue to them via their social networks and unconscious (therefore unquestioned) sense of privilege.

What shocks me about this is how dumb Blinder must think Taleb is. Having a financial broker diversify your cash into accounts, each with less than 100k, is an obvious trick. It’s also old – I had a Merrill Lynch account which could do this back in the 80s, although sadly it never did me any good, because I never had enough money. I guess it’s not the supposed corruption of the elite which worries me; it’s more their stupidity.

Is a mutual fund, then, also an “obvious trick”? Because, you know, it also diversifies your cash by splitting it among multiple investments. In fact, even your bank, to pay you interest on your deposits, makes multiple loans and diversifies its portfolio.

With all due respect, did you read my comment above? FDIC guaranteed accounts are NOT equivalent to money market mutual funds. Revere broke the buck, remember, and Treasury only MM funds offer lower yields.

And as I indicated, FDIC deposit insurance is underpriced, so taxpayers subsidize deposits. That is not the case with mutual funds (ex the few months post the run on Revere which led them to be guaranteed, but even then only up to $250K)

The comment on mutual funds was made in response to the statement “Having a financial broker diversify your cash into accounts, each with less than 100k, is an obvious trick.” As it stands, this comment implied that diversifying cash into multiple investments is a trick. In any case, I think you understand that this is not the main point being argued here. What is the reason for the FDIC limits? To spread institutional risk or to limit aggregate per person coverage? And does the government want the rich to reduce their bank deposits and buy treasury bills?

I didn’t mean “trick” in a pejorative sense. Would you prefer, “…is an obvious thing to do”? (Do you remember Climategate, where one of the researchers used the word “trick” and the whole right-wing anti-global warmers got really really upset? He’s using a “trick” on the data! The right-wing didn’t seem to understand that some people use “trick” in a non-pejorative way. I’m not saying you’re right wing, but get a handle on it, please, and don’t flip out because of the use of one word, which wasn’t meant in the way you are apparently taking it.)

I agree with Taleb’s overall main point, nonetheless I think the Taleb’s citation of Blinder selling a scheme to get around FDIC insurance is a little trite.

Far more troubling is the specter of Prof. Blinder, whom I have intellectual respect (I have read his economics textbook), is reduced to selling a simple end-around scheme, which was already well-known, at Davos in January 2009, where the main point of the conference was to develop ideas to solve the critical economic problems at that time.

A couple of corrections:

1) In January 2009, the FDIC insurance limit was already raised to $250,000.

2) It was the Reserve Primary fund that broke the buck in September 2008, not Revere.

Also, I have a little different take on financial innovations over the past 20 years and I do not agree with the following statement of Yves Smith.

“So the “innovation” that regulators, academics, consultants, and banks were all advocating more than 20 years ago was regulatory arbitrage, pure and simple.”

I think the innovations over the past 20 years was much more than that. The innovation maybe allowed some regulatory abitrage, but some of these innovations made economic sense without being applied to any regulations.

“Top bureaucrats were and are paid at the same level as private sector professionals (think top law firm partner)”
this is nearly impossible in today’s “damn overpaid lazy state worker” attitude society.

“But legalistic regulatory evasion has also become so commonplace as to blunt most people’s sense of where to draw the lines”
remember how we have been brainwashed to say “gov’t regulation bad”

I think we were basically “set-up” to follow this path. If I wanted you to hand me a million dollars, i would narrow your other possible choices down until you believed giving that money to me was in your best interest.

It’s sad that so many people here don’t want to just look at the facts of the case.

– There is nothing illegal or unethical here. The law is clear.
– Far from being an esoteric regulatory arbitrage scheme requiring “insider know how” or connections, the “brokered deposits” business is huge. Many companies are doing it, with no past regulators on their staff.
– Not only does the FDIC advertise the fact that multiple bank deposits are fine (and explains in detail how insurance covers them) — it also recognizes the existence of the same “brokered deposit” business that Taleb and Yves consider unethical AND REGULATES IT (by setting capitalization requirements that participating banks must meet).

Taleb seems to have bee unaware of the above. How a legal, government-regulated trillion-dollar industry can be portrayed here as an esoteric scheme for rich people to circumvent the law is a mystery. I would have hoped that fellow liberals would be more open to the facts of a case.

Which part of legal and ethical distinction don’t you understand? What’s legal is not necessarily ethical. We expect our civil servants to hold themselves up to a higher standard of ethics and not just legality.

Don’t waste time with this JS person. He/she obviously wants to believe what he/she wants to believe. People like that can’t see the nuances and the subtleties of the situation.

Probably a lawyer or lawyer wannabe (talk of facts, legality), I know many lawyers that can see both sides of this issue and have enough mental flexibility to change their minds

Good point and JS misses the point. Ethical is not legal. Lots of ethnic cleansing and even the holocaust were–legal. Lots of ugly things are legal and not ethical. Europes legal system is principle based as is governance (they learned) U.S. rule based and well no principles other than gaming rules for fun and profit. Don’t sweat it IL, the JS’s of the world (mostly in U.S) will never get it–some law created by special interested funded state legislatures or congress to benefit a group or industry is all of a sudden holy writ!

Yes, don’t bother with people who want to “talk of facts, legality” when we know so much better. IL, this line of thinking will take you straight to the Tea Party. When you make facts your enemy, you are going in the wrong direction.

So, Moe Green, who defines what is ethical or unethical? Taleb, who believes that we shouldn’t spend money on a stimulus to combat high unemployment because it will increase the deficit? Is he the arbiter of ethics for you? And how is this technical banking structure (which, again, is explicitly regulated by the FDIC) like ethnic cleansing, discrimination, and the holocaust? You are grasping for straws.

I assumed everyone else knew something I didn’t with regards to this story…in fact, rather than saying that it was unethical, I simply applied it as another instance of regulatory capture…though that’s a stretch with this story I suppose.

Yves herself is applying a “unethical for the former public official” argument to be making money because of his former position in government. In my opinion there is nothing wrong with this UNLESS it implies a character that may have been captured by the industry while in power.

As I mentioned above, there are many companies doing this and there is no insider know how or connections required. There are no regulatory gaps (the FDIC recognizes these accounts and regulates them with explicit rules!) and no regulatory capture (anyone can start such a company without hiring a previous regulator). The FDIC exists not only to protect private accounts but also to provide stability to the banking system. If the large depositors had no way to get insurance, they would pull their money out of banks en masse at the first sign of trouble, and that would cause bank runs. That wouldn’t help anybody.

When I say “regulatory capture”, I mean using tactics AFTER retiring as a federal official that would suggest you never quite followed, or more importantly, BELIEVED IN what you were doing before. This is very important in retrospect, as you can see what events did or did not occur as a result of the people in power.

My standard is not “making money.” It’s former regulators trading on their status as a former regulator, which is a subtle distinction. Note the comment higher in the thread, we used to criticize the Japanese in the 1980s for merely having former regulators take jobs in private sector firms when they semi-retired. These positions did not involve lobbying or interacting with officials (I know, I worked for Sumitomo Bank and knew how they “managed” their relationship with the MOF).

For instance, Paul Volcker joined Jim Wolfensohn’s firm some years after his time at the Fed. Wolfensohn’s shop was an M&A/private equity boutique. It wasn’t a big player in financial institutions before or after Volcker joined.

Not grasping at straws–just demonstrating that legal does not equal ethical. Now you change your stance to whether Taleb is the arbiter of ethics. Since legality is not ethics then what ethics do we follow? Then Ives point is amptly made–the people in D.C. and finance industry are unethical or even say non-ethical. There are many ethical guidelines,precepts that can be used, the swiss, singaporeans, autralians and others run pretty clean shops fairly free of lobbyists, revolving door and the horrfic state of regualtory capture—alas the U.S. 5% of population and 70% of lawyers. Well at least now you may grasp that legal is not ethical. Or maybe not…..

I did not change any stance Moe, I addressed the question of whether this was ethical or not in several of my comments above. In fact, that was my main point from the beginning, since Yves had accepted that this is legal. Nobody has explained yet why it is unethical to engage in a business that is open and regulated. Taleb is obviously misinformed when he says that people like Blinder “benefit from glitches in the system”. It’s not a “glitch” when the government recognizes it and regulates it.

If the complaint is that Blinder used to be a regulator and now works for a financial institution — OK. I have sympathy with that, and I would vote to make it illegal. But that was not Taleb’s main point. He seemed to think that what Blinder’s company was doing was using his isider expertise and connections to take advantage of a gap, a “glitch”, and in that he was wrong.

How about that by proxy a public servant can gain information and establish contacts that afterwards be use in such a manner that is detritus to his previous ethos (serve the commons) ie: the commons gave them power (public trust) only to have that gift used to enrich them selves and their betters, after the fact and many times too the commons diminishment.

BTW do you feel that Taleb was soft peddling for political reasons, he would have bigger smoking guns than the one he used, still early days.

To answer both Deus-DJ (10:35 pm) and Skippy: Yes, as I mentioned above, having a government regulator subsequently work for a company subject to the regulation he/she was previously involved in CAN lead to unethical behavior. But you cannot, merely by the existence of such an association, argue or prove that the company’s activity is indeed unethical. And in any case, this was not Taleb’s argument — rather, he held the view that the business of brokered deposits was unethical of itself, and wouldn’t be possible without some insider sleight of hand (and in this is demonstrably and factually wrong).

Taleb is a brilliant guy, and I have read his book and I think everybody should read it. But reading it, and also watching him speak (on YouTube) I think most people would agree that he is not a man of measured words. He talks a lot, about many subjects he has no expertise in, loves to accuse others and make himself look virtuous and wise, and frankly shoots off his mouth way too much. His overall message about the significance of low probability events is important, but a lot of the detailed he goes into are not fully thought out.

Taleb is also primarily a conservative, whereas Blinder is a liberal economist (and not so much a banker — he is a tenured professor at Princeton). Taleb and Blinder have appeared on TV discussion panels together, and there may have been disagreements that created bad blood (though I don’t know this for sure).

Thank you for your reply JS…I agree that the state of affairs is convoluted but, to be simplistic, if one leaves food scrapes at the back door (out of convenience or incentive) and the critters upset the laws of nature (equilibrium) and then use them to set food upon the masters table_at_their leisure, does that bode well for the hole of us.

Skippy…was I a better soldier because of my personal body count or the humanity I learned from it.

“I agree with Taleb’s point but I think his choice of examples is not particularly good. He’s referencing the CDARs program which allows people with more than $100K to deposit in a bank (actually I believe it’s now $250K) to essentially spread around their deposits more easily….

So, this isn’t really a “subsidy for the rich.” The rich, after all, could do this themselves”

Actually, I think it’s a very good example–Taleb just didn’t explicitly connect all the dots.

I think he concedes that it’s “technically legal” but says it IS unethical because if a US regulator’s public purpose is to secure the stability of the financial system, then former regulators really ought not turn around and start effectively PEDDLING moral hazard.

Enabling the extremely wealthy to easily get their funds insured by the government by exploiting a technical loophole just encourages the kind of reckless disregard for risk in the financial sector that we JUST NOW experienced.

Throughout all of this, Blinder is also trading on his reputation/ expertise in the public square. The public should be able to assume that when experts discuss the financial crisis, that those experts are not currently talking out both sides of their mouths, literally fostering the next one.

Is Blinder really so Blind that he can’t see how he’s actively participating in that?

It also annoys me that people pretend he’s a “liberal” and a “democrat,”–he’s a tenured professor at Princeton! of course he’s a democrat!– but that’s a separate issue.

This whole issue seems silly. I understand where he is coming from but this is not some big Loophole being taken advantage of. You can deposit more then $250,000 and get the FDIC protection by using the FDIC SUPPORTED “CDARS” program or “Certificate of Deposit Account Registry Service”. This is not some small “loophole” it is supposed to be this way. The deposit insurance is so that the FDIC won’t pay out more then $250,000 for 1 bank failure to 1 person.